What goes up must come down sounds better in song than in a stock market, and certainly it has not been true in America for quite some time. That being said, it is clear that the markets have finally noticed that something is awry with the structure of the American economy.
Unlike the professional analysts, I will not pretend to be able to say if this is primarily due to the loss of confidence in the system’s integrity represented by the Enron-Arthur Andersen scandal, the continuing interference of government in the economy as represented by the Microsoft lawsuits, the statistical indicators, terrorism or the pending war.
Furthermore, being of the Austrian school of economics, my rejection of the entire field of macroeconomics means that if you would like a detailed statistical analysis, you will have to look elsewhere. If one is interested in fairy tales, then it should suffice to point out that an AFC team, the New England Patriots, won the Super Bowl this January and so a down market is inevitable.
But even if the statistical numbers are nothing more than frighteningly inaccurate estimates, this does not mean that they cannot be used to observe obvious trends. As has been said for years, foreign investors cannot be expected to finance the American trade deficit forever. A trade deficit normally creates a weaker currency – one that is worth less – although the U.S. has been largely immune to this in recent years because its currency has been, in effect, the global standard. As long as foreign investors were willing to keep their holdings denominated in dollars – either in the form of cash, stock, bonds or real estate – the trade deficit was not an immediate problem.
A weak dollar is not necessarily bad, because it makes investing in the U.S. a relative bargain. The problem arises when confidence is lost in both the dollar and U.S. assets. If the stock market is declining alongside the value of the dollar, this is an indication that foreign investors prefer to own non-U.S. stocks or keep their money in euros, francs or pounds. Since the historical P/E ratio of the S&P 500 is 15.5, the run up to 43.22 at the end of May was a strong indication that the U.S. stock market was very overpriced. While the dollar index is still reasonably strong, at 108, it does represent a fairly steep drop from over 120 at the beginning of the year.
And while it is anathema for most televised market analysts to discuss the probability of a serious downturn, the fact is that if these simultaneous declines in the dollar index and the stock market do indicate a newfound distaste for U.S. investment on the part of foreign investors, it is quite possible for the market to return to what would, historically speaking, be considered normal levels. Which would be, for most investors, A Very Unpleasant Thing.
Indeed, I suspect that the introduction of the Euro may have played a role in this new development – not so much because it is a competitor to the dollar, but because millions of Europeans saw their familiar currencies become worthless overnight by government dictate. They understand viscerally, in a way that we cannot, that a dollar is nothing but paper and an electronic bank account denominated in dollars is something even less.
I think that this may be a contributing factor in explaining why the price of gold, long the historical monetary standard, has risen from $260 in April, 2001, to $324 this week despite massive sales by central banks around the world. Metal investments look particularly interesting when you consider that the gold price was as high as $420 as recently as 1996, and up to $675 during the last major recession of 1982.
Now there are those who will point out that stocks always rise in the long run, and certainly if you look at charts tracking the Dow Jones average over time, this appears to be true. The problem, of course, is that of the companies which made up the Dow 100 years ago, exactly one company, General Electric, remains. So much for learning from history.
I am not, like the Marxists, predicting inevitable capitalist doom. However, I do suggest that this is a good time to pay closer attention to the markets, do some research and consider your investing alternatives.